FIFO, short for “first in first out”, is an accounting method that involves selling the shares that were acquired first.
FIFO principle for buying and selling shares
When buying and selling shares in the same company multiple times, the profit should be calculated according to the FIFO principle.
The FIFO method requires selling the shares you acquired first when you want to sell shares in a company. Instead of combining the shares and then determining an average price for the profit, you use the prices/rates of the shares you initially bought before moving on to shares purchased at different prices/rates.
FIFO method example
The FIFO method is best explained with an example.
Let’s start with the following:
- You purchase 100 shares on 1st January for 5 Australian Dollars per share.
- You buy an additional 50 shares on 1st February for 10 Australian Dollars per share.
- Then you sell 110 shares on the 25h of February for 8 Australian Dollars per share.
When calculating the profitability of the transactions, the Australian Tax Administration requires that the shares are sold in the order they were purchased. They first determine the profit on the first 100 shares you bought, and then on the next 10 shares sold from the second share purchase.
By applying the FIFO method, we find that the profit, which is subject to individual taxation, is 280 Australian Dollars.
FIFO alternative
There are different ways to value shares. Alongside FIFO, some companies use LIFO and weighted average price.
LIFO, or “last in first out”, is the opposite of FIFO. With the LIFO method, you sell the shares you most recently purchased first.
Weighted average price is another method for calculating the cost price of shares or assets, particularly when multiple purchase transactions have been made at varying prices over time. Instead of computing each transaction separately, the weighted average price determines the average price per unit based on both the number of units and the total purchase amount.
The Australian Tax Administration does not explicitly mandate the use of the First-In, First-Out (FIFO) method for tax purposes. Nevertheless, the Australian Taxation Office (ATO) is entrusted with the task of gathering, retaining, utilising, and disclosing essential personal information concerning individuals and taxpayers. These activities are conducted to effectively administer taxation laws.